What’s the Difference Between Depreciation and Amortization

Picture yourself trapped in a maze, but instead of hedges, you're surrounded by terms like 'depreciation,' 'amortization,' 'goodwill,' and 'tangible assets.' Sound familiar? Welcome to the intricate world of accounting. But fear not, our U.S.-based experts at Bookkeeper360 are here to guide you out of this labyrinth, especially if you're running a small business and need tailored solutions. Buckle up as we demystify depreciation and amortization.

Key Differences of Depreciation and Amortization

Both depreciation and amortization involve spreading out the cost of an asset over its useful life. However, the primary difference lies in the nature of the assets they relate to.

Depreciation applies to tangible assets — think buildings, machinery, vehicles — assets you can touch and feel. Over time, these assets wear out, get old, or become outdated due to advancements in technology, causing their value to decrease. That’s depreciation.

Amortization, on the other hand, applies to intangible assets — such as patents, trademarks, and goodwill. These assets might not physically wear out, but they can become less valuable over time due to factors like market changes or expiry of the asset's legal life. That’s amortization.

The ABCs of Depreciation and Amortization

Here's a simple rundown of the process:

  • Identify the asset’s initial cost.
  • Determine the asset’s useful life.
  • Decide on the method of depreciation or amortization.
  • Calculate the yearly expense.
  • Record the expense in your accounting books.

Remember, no matter if it's depreciation or amortization, the aim is to match the cost of the asset and spread it over its useable life.

Unraveling the Mysteries of Accounting: A Real-Life Story

Let's take an example of a small business owner, John, who had just started his ice-cream parlor. He purchased an ice-cream machine worth $10,000, with a useful life of 10 years and no salvage value. In John's accounting books, he wouldn't record the entire $10,000 as an expense in the first year itself. Instead, he would depreciate the machine evenly over 10 years, recording a $1,000 depreciation expense annually. This method helped John balance his expenses and revenue over the years, providing a more accurate picture of his parlor's profitability.

FAQs about Depreciation and Amortization

Q: Can I choose not to depreciate or amortize my assets?

A: Technically, yes, but it isn't recommended. Depreciating or amortizing your assets can provide tax benefits and aligns with Generally Accepted Accounting Principles (GAAP)..

Q: How do I choose the method of depreciation or amortization?

A: The method should reflect how the asset is expected to generate benefits. Consulting with accounting professionals, like the ones at Bookkeeper360, can help you make an informed decision.

Get ahead in your business by understanding your assets better. Empower your business today with Bookkeeper360's technology-driven accounting solutions. Our U.S.-based experts are ready to handle your accounting, payroll, and tax compliance needs. Contact us today and start your journey to better accounting.